01/03/23 08:44 AM EST

REITS DAILY BRIEF | INITIAL THOUGHTS ON EPR | 1.3.23 (EPR)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Happy New Year, let's get after it!

Hedgeye Cartoon of the Day: Reformed Viewer

It is 1.3.23, and Active Short MPW is overvalued by approximately... whatever the current share price is.

Ticker: EPR

Company Name: Active Short EPR Properties

Subsector: Triple-Nets

Headline: Thinking through EPR in steps, similar to MPW...

We had to delay our Black Book presentation on Active Short EPR for a few reasons, so apologies on that! As a reminder, we will now be holding it on Thursday, 1/5 at 12:30pm ET. In the interim we wanted to provide some preliminary thoughts before the deeper dive.
Going through the MPW experience last year helped us refine our process in looking at triple-net REITs. We find that it helps to start with the questions: (1) what unlevered returns do the existing assets generate, (2) how does this return profile compare to a reasonable estimate of the company's cost of capital, and then (3) given #'s 1 & 2, what is the company worth today applying a "justified" book value or EBITDA multiple? Then from there, ask the questions: (1) can the company grow externally on an accretive basis, which is really a RoC question (no in this case), and (2) are there any potential tenant credit issues lurking which could torpedo forward numbers, the divided, etc. (yes in this case, which we will go through on Thursday)?
In general, the math doesn't lie when it comes to return profiles. It is a readily observable metric that leads to a simple cost of capital and valuation exercise.
To the very first point above, we compared EPR's historical Adj. Cash EBITDA against our calculation of Gross Assets, or the aggregate amount of capital invested to generate those earnings streams. This calculation captures the economics of just the fee simple real estate, and excludes EPR's ~$400 million of debt investments. We then add the BV of the debt investments later. We calculate Gross Assets as: Total Assets + accumulated D&A - Cash - BV of Land and Property Under Development (which are not yet income generating) - Operating Lease Right-of-Use Assets - BV of Mortgages + EPR's Share of UJV Assets. As can be seen in Figure 1 below, realized unlevered returns for the fee simple real estate are pretty consistent around ~8% since 1Q11, obviously excluding the Covid period during which EPR granted cash rent deferrals, etc.
Moving forward from there, with EPR's debt yielding ~8% and the stock carrying a dividend yield near ~9%, we think it is fair to assume a blended unlevered cost of capital in the 10-10.5% range. Immediately from this we know the following: (1) EPR is not earning its cost of capital and should, therefore, trade at a discount to the book value of its assets, and (2) the forward RoC profile will be inferior to other higher-quality triple-nets that can issue debt and equity and grow externally through acquisitions and selective development. See Realty Income's (O) recent ~$1 billion acquisition at a ~7.1% cash cap rate as an example. We run through the math in Figure 2 below, with a calculated or "justified" book value multiple of ~0.7x.
Applying this to EPR's gross assets and running the result through the capital structure produces an equity value of ~$25/share, or ~33% below the current share price, and this is before any potential rent cuts from problem theater tenants and the related impairments to the real estate.
We wanted to provide this initial view, and will go deeper into the story on Thursday.